Mixed economic data means bulls and bears both have a strong case


Martin Pelletier: But the truth may be between the two

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There has been no place to hide in the markets this year other than energy stocks. But they too became the last segment to correct, selling off in June before starting to recover in July. Looking ahead, we are closely watching three key factors that we believe will determine the future direction of the markets and whether or not the current recovery is sustainable.

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Interest rate

Interest rates have become the driving factor in the markets, especially among longer duration segments such as bonds and tech stocks. Whenever there is disappointing economic news, like last week’s negative 0.9% GDP print, experts believe the Federal Reserve will pivot on its tightening, sending markets higher. In other words, bad news is good news again.

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Overall, we would not be surprised to see an improvement in inflationary pressures in the coming months as we are already witnessing a significant decline in commodity prices. For example, corn, wheat and steel prices are down 30-40% from their peaks, putting them at levels seen before the Russian invasion of Ukraine. At the same time, oil and gasoline prices are also falling, easing pressure on the US consumer. In our view, commodity prices have taken a lead on the upside, but perhaps they have also overreacted on the downside?

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We think it’s important to remember that things aren’t always as clear cut as they seem.

Ben Carlson, director of institutional asset management at Ritholtz Wealth Management, summed it up perfectly in a recent tweet: “Welcome to confirmation bias economics. Want to see a recession? Just look at GDP, rates, inflation, retail and consumer sentiment. Don’t want to see a recession? just look at the labor market, personal income and travel/services.”

The mixed data makes it difficult to determine when the pace of rate hikes will slow and eventually come to an end. To complicate matters, we believe commodity prices will continue to exhibit volatility as tight supply and demand concerns create periods of higher and lower inflation. At the same time, we are concerned that those most exposed to duration will let their confirmation bias take over, resulting in one-way bets all hinged on a Federal Reserve pivot. In fact, we believe there are many areas within the economy that can sustain higher interest rates, as evidenced by recent Q2 reports.

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business profits

Earnings have historically held up relatively well during periods of inflation, if the 1940s and 1970s are to be believed. Microsoft Corp., Meta Platforms, Inc., Alphabet Inc., Apple Inc., and Amazon.com Inc.

Again, we can select the data that best matches your view of the markets. The bears will look at disappointing numbers from Walmart Inc. while the bulls will cite the better than expected second quarter from Apple or Amazon. Apple reported a beat on revenue and earnings and expects growth to accelerate. Amazon, despite the broader consumer shift from spending on goods to services, still expects impressive 13-17% revenue growth after the third quarter. Meanwhile, Walmart, whose forward sales are expected to hit 6%, is cutting prices to try to manage its excess inventory levels.

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Overall, we believe this quarter shows that the pace of growth is slowing in some areas and showing resilience in others. This is important, especially given the magnitude of multiple compression that has already occurred this year.

Ratings

On the valuation side, markets have clearly reset, with the S&P 500 P/E falling 23x to 16.9x (vs. 15.3x reached in June). Based on historical data, it incorporates 65% of a recessionary correction. While we’re not brave enough to say this is officially a low, we think it’s definitely worth adding positions, especially among the few people who were able to protect some of decline this year.

Looking ahead, we see a lot of value in certain market segments, such as the financial services sector, including Canadian and US banks. We also like some of the S&P leaders like Apple, Amazon and Microsoft trading at somewhat attractive multiples, especially now that they have just released their report.

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That said, we are concerned about the more speculative technology segments of the market, such as companies with low cash flow and dependent on a low ongoing cost of capital. So be careful not to be seduced into adding excessive duration risk, especially as inflation volatility continues.

Finally, we continue to believe that we are in the early stages of a commodity supercycle with very favorable longer cycle conditions. The good news is that the June sale may have been a second chance for those who missed out on the trade earlier this year.

In conclusion, we find it pays to be optimistic when everyone else is pessimistic, don’t bet on central bankers and instead focus on areas of the market that can make money, generate cash flow strong cash flow and grow in a higher interest rate. environment.

Martin Pelletier, CFA, is a Senior Portfolio Manager at Wellington-Altus Private Counsel Inc, trading as TriVest Wealth Counsel, a private client and institutional investment firm specializing in risk-managed discretionary portfolios, audit /investment monitoring and advanced tax, estate and wealth planning.

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